COMMENT: Whisper it – ‘Erdonomics’ could be driving Turkey to a meltdown

Will the president have enough rabbits to pull out of his hat in the run-up to the next presidential election?

By Will Conroy in PragueApril 9, 2018

Turkish President Recep Tayyip Erdogan on April 9 was unmoved in the face of the sliding Turkish lira (TRY), reiterating unorthodox monetary policies that have unnerved many investors and repeating his hard-nosed insistence that interest rates need to be lowered to “save” investors.

As the TRY registered yet another all-time low against the dollar—one USD was fetching TRY4.0755 in morning trading before trimming its losses to 4.0599 by around 21:30 Istanbul time—and broke the 5.0 threshold against the euro for the first time—touching 5.001 against the single currency—Erdogan again knocked away the argument that monetary tightening is required to address Turkey’s double digit inflation, one of the world’s worst current account deficits and the fast depreciating Turkish currency, down around 7% against the greenback so far this year. What’s more, the populist president’s latest intractable stance on monetary policy amid an overheating economy heightened concern on the markets that the independence of the Turkish central bank has essentially been lost.

“How will there be investments if you do not bring down interest rates? We call this an investment-based incentive system,” a pugnacious Erdogan said in a speech in Ankara, where he unveiled a $34bn investment incentive package to help Turkish companies. “You have to save the investor from high interest rates so that these investments could be made.” he added.

Despite the sheer weight of analytical opinion against him, Erdogan lashed out at those who claim Turkey’s astrononomic growth rates are excessive, claiming they speak out of jealousy. Turkish growth was creating more just income distribution and he was hopeful that unemployment would soon drop below 10%. Growth means investment, investment means employment, production, technology, exports and prosperity, ran Erdogan’s argument.

Erdogan wastes no opportunity to urge banks to lend more money to the economy to spur growth and April 9 brought local media reports that cash-hungry lenders were now offering the highest rates on lira deposits since the aftermath of the global financial crisis. They cited Bloomberg HT television data detailing how average interest rates on overal deposits stood at 12.81% at the end of March. Turkey’s high inflation, at around 10.2%, has caused interest rates on loans to rise towards an annual 20%, curbing demand for credits from businesses and consumers.

Past form
William Jackson, senior emerging markets economist at Capital Economics, said that “if past form is anything to go by”, the lira would need to drop by another 5% or so, to about TRY4.25 to the dollar, in the next week or two to prompt a significant monetary policy response from the Central Bank of the Republic of Turkey (CBRT). But there are those who wonder if even then it would dare act in the face of ‘Erdonomics’.

He added: “Of course, demands from the government make it difficult to predict what will happen, but it’s worth noting that the central bank faced similar rhetoric from the authorities prior to the hikes in 2014 and 2017. The big test will come at the next MPC [monetary policy committee] meeting on 25th April. If the lira remains under pressure at that point and central bank doesn’t tighten policy that will reinforce concerns that it is bowing to the government which could cause the downward spiral in the lira to gather pace.”

“This mismanagement of the currency leads to a loss of confidence in the purchasing power of the lira which is hard to cure,” Lutz Roehmeyer, who helps oversee about $14bn at Landesbank Berlin Investment, told Bloomberg on April 9. “Only massive one-off hikes can heal this situation, which is of course not popular as it slows the economy."

Two camps
Timothy Ash, senior emerging markets sovereign strategist at BlueBay Asset Management, said in a note that the government’s seeming prioritisation of more stimulus measures over "re-balancing" continued to unnerve investors. He added: “There are two camps in the Erdogan administration: the first in the go for growth camp, around [senior advisor to the president] Yigit Bulut; and then the more orthodox team rolled out to talk to foreign investors… who talk in favour of the need for ‘rebalancing’.

“At the moment, as per the administration's actions, the former camp seems to be winning—the Erdogan administration seems to be going for growth, at all costs, and without a willingness to hike policy rates, the lira has to take the strain.”

JPMorgan Chase & Co. said in a note that it remained underweight Turkey’s currency and bonds. It pointed to a current-account deficit that it forecasts will expand to 6% of output in 2018 and a deteriorating inflation outlook. The nation needs a “sizable” foreign-exchange adjustment and credible policy response, which may not be “imminent,” the bank said in a note released on April 6.

Turkish bonds fell on the day, pushing the yield on benchmark 10-year notes 8 basis points higher to 13.15%. That is close to the record high recorded last week.

The investment incentives announced by Erdogan will comprise of TRY137.4 bn being awarded to projects by companies including Vestel, Tosyali, Metcap and Sasa, the economy ministry said. The 23 projects would create 35,000 jobs and contribute $19bn to the current account, it added. The incentive package, according to the president, includes exemptions from customs tariffs and government support for employee insurance premiums.

Turkey’s latest current account data will be release on April 11. The account’s huge deficit makes Turkey reliant on foreign investment flows. Moody’s Investors Service referred to concerns about that deficit when it cut Turkey’s sovereign debt rating further into junk territory last month, a move that drew Erdogan’s ire.

The lira is the fourth-worst performer so far this year among more than 20 emerging market currencies.

"Hasta la vista, Andy!" wrote Hungarian PM Viktor Orban to the former Hollywood producer who revived Hungary's film industry, but was criticised for his involvement in pro-government media.

2018 is now behind us and it was a painful year for most investors around the world, across all asset classes. In USD terms, MSCI indices for frontier and emerging markets ended the year with a negative total return of 16.4% and 14.5%

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